Cost accounting

1. COST MANAGEMENT BASICS Cost accounting 1

2. Agenda Accounting Overview Financial Accounting Budgetary Accounting Management Accounting Output Costs Transfer Pricing 2

3. Accounting Overview 3

4. Definition of Accounting “is the production of financial records about an organization. Accountancy generally produces financial statements that show in money terms the economic resources under the control of management; selecting information that is relevant and representing it faithfully. The principles of accountancy are applied to accounting, bookkeeping, and auditing.” Source Wikipedia 4

5. Accounting Domains Financial Accounting – focuses on reporting to external users (e.g. investors, creditors, and governmental agencies) to communicate a financial position BudgetaryAccounting- the process of implementing a budget and the consumption of the budget utilizing special subset of accounts. An additional accounting requirement for State or Federal Government funded entities Cost Accounting– records, measures, analyzes and reports financial and non-financial information to managers to aide in making decisions to meet objectives. Commonly referred to as managerial accounting 5

6. Financial Accounting • Concerned with preparation of financial statements for external users (e.g. investors, creditors, and governmental agencies) to communicate a financial position • Primary users are external looking to judge the health of the entity and for comparison with other entities • Not intended for day-to-day running of the company/organization since historical in nature (monthly, quarterly, annual reports) • Govern by local and international accounting standards; e.g. Financial Accounting Standards Board (FASB) • Follows Generally Accepted Accounting Principles (GAAP) • Certification/Professionals are CPAs • Has limited influence on employee behavior outside of employee stock holding 6

7. Budgetary Accounting • Concerned with preparation of budgetary statements for external users (e.g. governmental agencies) to communicate a budget position • Primary users are external looking to judge the compliance of a government entity to funded Budgets • Not intended for day-to-day running of the company/organization since historical in nature (monthly, quarterly, annual reports) • Govern by oversight entities; e.g. Government Accounting Standards Board (GASB), • Typically follows Generally Accepted Accounting Principles (GAAP) with some differences • Certification/Professionals are CGFMs • Has limited influence on employee behavior (influences when to consume budget) 7

8. Cost/Managerial Accounting • Concerned with preparation of statements for internal users (e.g. Product Line or Customer Managers) to communicate a Profit/Loss position • Primary users are internal management looking to benchmark the management of inputs with corresponding outputs • Intended for day-to-day running of the company/organization since predictive in nature (daily, monthly, quarterly, annual, forecasts, simulations) • Not governed to a specific rule or formatting; focus is information to make appropriate decisions • Typically follows Generally Accepted Accounting Principles (GAAP) with some differences • Certification/Professionals are any focusing on efficiency/effectiveness or performance improvements (e.g. CMAs, Internal Auditors, PMPs) • Designed to influence employee behavior (change process to decrease costs, spend $ to increase market-share, etc.) 8

9. Summary of Accounting Domains 4

10. Financial Accounting 10

11. Accounting Methods • Cash Basis: Record when Pay • Accrual Basis: Record when receive the Benefit Plan Order Receive Pay Plan Order Receive Pay 11

12. The Accrual Basis of Accounting • Focuses on exchange of Economic Resources • Records Revenues in the period in which they are EARNED • Providing a service • Selling a product Plan Take Orders Complete Service or Ship Product Collect Cash Revenue & Non-Cash Asset 12

13. Revenue Comparison • Cash Basis: • Accrual Basis: Plan Take Orders Complete Service or Ship Product Collect Cash Plan Take Orders Complete Service or Ship Product Collect Cash Revenue & Non-Cash Asset 13

14. The Accrual Basis of Accounting • “Matches” Revenues with Expenses • It takes money to make money • Records Expenses in period INCURRED • Resources Consumed Plan Order Receive Pay Asset & Liability  Remove Liability  Expense 14

15. What is the Accounting Cycle? The Accounting Cycle is the systematic process by which accounting information is recorded, compiled, and reported to users. 15

16. The Financial Accounting Cycle Record Transactions Post-Closing Trial Balance Post to Ledger Close Accounts Prepare Trial Balance Prepare Statements Adjust Accounts Adjusted Trial Balance 16

17. The Journal • Accounting events are recorded in the JOURNAL • The Journal is a chronological record of all transactions • Each transaction requires a journal entry • Each journal entry consists of at least one Debit and one Credit: “Double Entry” Accounting • Debit amounts must equal Credit amounts • Debit: an entry on the left-hand side of the account • Credit: an entry on the right-hand side of the account 17

18. Debits and Credits • Debits and credits are neutral • Debit ≠ decrease • Credit ≠ increase • It depends on the type of account • Some accounts types record increases with a debit, some record increases with a credit • The side of the account which records an increase is the account’s NORMAL BALANCE 18

19. Anatomy of a Journal Entry Amount Debited & Credited Explanation of Transaction 19

20. 2 Basic Types of Adjustments • Prepayments: Cash is paid before the resource is consumed • When cash is paid in advance, an asset is created • At the end of the period, some of the asset may have been consumed  expense Pay Consume Record Asset  Reduce Asset, Record Expense 20

21. 2 Basic Types of Adjustments • Accruals: Resources have been consumed but no cash has been paid • Results in a liability Consume Pay Expense & Liability  Remove Liability 21

22. Equipment and Depreciation • Depreciation is the accounting process of assigning a portion of equipment’s cost to the periods in which it is used • A portion of the benefit of owning the equipment has been received in the current period  expense • The future benefit is reduced • There is Financial depreciation which tends to be straight-line (Tank life is expected to be 10 years) and Cost Depreciation which tends to be usage-based (Tank life is 100000 kilometers) 22

23. Budgetary Accounting 23

24. Budgetary Accounting • Provides a control mechanism to prevent overspending funds • Does proper budgetary accounting prevent deficits? Why or why not? • It DOES prevent overspending • It does NOT prevent revenue shortfalls • It does NOT prevent over-appropriating by the legislative body 24

25. Focused on the “Budget” domain The “Budget” domain consists of creation of the budget requests/submissions, determination of the year of execution budget (e.g. availability control and informal budgets), actual execution, and reporting of the status of execution against the budget (e.g. the PPB&E process) Primary focus of budget execution is the Obligation (consumption of the budget) Budget Accounting focuses on 4 series accounts – status of Budget and consumption Budget Management focuses on the status of available funds, which includes both current and prior years funds Current Army Focus 25

26. Budget = What Can Be Spent Commitment = a thought to procure a product/service Obligation = a promise to procure a product/ service (e.g. to spend) Budget  Obligations Budget – Obligations = Availability (e.g. what is left to spend) Expenditure is the receipt of the product/service which was obligated (e.g. what was spent) Expenditures or collection of expenses/expenditures determines Costs Disbursement is the outlay of cash Budget Terms 26

27. Budgetary Comparison • Cash Basis: • Accrual Basis: • Budgetary Basis: Plan Order Receive Pay Commitment  Obligation  Expenditure  Disbursement Plan Order Receive Pay Plan Order Receive Pay 27

28. The Budgetary Accounting Cycle Obtain Budget Revenue Close Budget Year Distribute to Allotment Manage Availability Commit Funds Disburse Cash Obligate Funds Expense Funds 28

29. The Budgetary Accounts • Exist solely for the purpose of recording and tracking the budget • Budget = a legally binding spending plan • Account Titles: • Estimated Revenue = Expected Income • Appropriations = Authorized Spending • Budgetary Fund Balance = Planned Change • Unreserved Fund Balance = Savings 29

30. Procurement Process 30

31. Budgeting Participation Encourage top-down flow of information and plans Budgets attempt to Encourage bottom-up flow of information 31

32. IMCOM Jackson Benning Knox Budget - Color of Money Appropriations Program Elements Fund Centers $ OMA $ BOS $ $ SRM AFH $ GFEBS $ RDT&E Elements Of Resources Supplies Training Travel Equipment Labor Etc. 32

33. Cost Vs.Budget Knowing your obligations is not the same as knowing your costs! A legally binding commitment by the federal government that will result in outlays, immediately or in the future. Budgetary resources must be available before obligations can be incurred legally. Obligations The price or cash value of resources used (expenditures) to produce a program, project or activity. All relevant costs may not appear in the organization’s budget. Costs Cost Obligation Full cost can exceed individual business unit budget allocations Costs Obligations Cost will contain expenses from different years, source of funds, organizations, etc. 33

34. Budget President’s financial plan and the priorities for the Federal Government Budget vs Cost Domains Budget Formulation Budget Execution Cost Management • Budget Authority • Authority to incur obligations • Cost • Valuation of resources used to produce outputs, basis for decision making • Focus • requirements • Focus • availability, obligations • Focus • full costs, Plan vs. Actual • Key Data Elements • appropriation, FTE • Key Data Elements • appropriations, EOR’s, PE, MDEP, projects, BLIN, etc. • Key Data Elements • operational entity (e.g. cost centers), services, rates, products, projects, etc. • Questions • What funding did I get? • What obligations were executed? • Questions • What was expensed? • What did I get for it? • How well was it used? • Questions • What do I need? • What will I ask for? 34

35. Managerial Accounting 35

36. Three Common Features of Cost Accounting • Calculates the cost of products, services, and other cost objects • Tracks information for planning & control, and performance evaluation • Analyzes relevant information for decision making 36

37. …. “a cost is the value of money that has been used up to produce something” An Easy Definition of Cost # Clean Dishes 37

38. Basic Cost Terms • Cost: a sacrifice of resources • Cost Object: any item or activity for which a separate measurement of cost is desired – cost objects are the “something” in a statement • Cost Driver: any factor whose change ‘causes’ a change in the total cost of a related cost object – cost drivers can be factors other than volume 38

39. The Many Types of ‘Cost’ • Direct Cost: a cost such as labor, material/supplies that can be directly traced to producing a specific output of organization, product, or service • Indirect Cost: a cost that cannot be directly traced to a specific organization, product or service output • Funded Cost: the value of goods or services received because of an obligation of funds (obligation authority), by an organization performing the work • Unfunded Cost: a cost that is financed by another organization’s or activity’s appropriations • Variable Cost: a cost that changes with change in the output • Fixed Cost: a cost that remains the same regardless of the change in output • Recurring Cost: a cost that is incurred repeatedly for each organization and/or product and service produced • Non-recurring Cost: a cost that is unusual and unlikely to occur again • Avoidable Cost: a cost incurred on an object that will no longer be incurred due to a decision to change the output • Unavoidable Cost: a cost incurred on an object that will be incurred regardless of the decision to change • Common understanding of different types of costs is necessary for informed decision making • Each decision should be focused on ONLY relevant cost that impact the decision 39

40. Some Characteristics of Costs Costs may be: • Direct or indirect • Recurring or nonrecurring • Burdened or unburdened • Variable or fixed 40

41. Direct vs. Indirect Direct Cost • Can be easily and conveniently traced to a specific cost element/objective • Example: The cost of ammunition fired in a training event at the firing range Indirect Cost • Cannot be easily and conveniently traced to a specific cost element/objective • Example: Installation support to the firing range (utilities, upkeep, etc) 41

42. Recurring vs. Non-recurring Recurring Cost • Cost that is incurred regularly in producing a product or providing a service • Examples: Civilian and military personnel who conduct the activity, recurring sustainment of facilities, supplies, personnel training, utilities, equipment maintenance, janitorial service, office supplies Non-Recurring Cost • Cost that only occur once or infrequently. • Examples: Major items of equipment, major and minor construction, one-time training in new procedures, activities conducted in direct support of individual process improvement efforts 42

43. Burdened vs. Unburdened Unburdened Cost • Cost of a product/service that does not consider other related costs necessary to provide that product/service. • Examples: Direct compensation, cost of a gallon of fuel in a theater of operations, etc. Burdened Cost • Cost of a product/service plus an apportioned cost of other related costs necessary to provide that product/service. • Examples: Salary plus the cost of benefits (health, retirement, etc.), facilities support cost allocated to an activity or personnel • There are degrees of burden in a CBA. For example: • Direct compensation for military and civilian personnel is always burdened with the cost of personnel benefits • Facilities support cost is allocated to a COA only if it can demonstrated that the COA causes the cost to be incurred 43

44. Variable vs. Fixed Variable Cost • A cost that varies based on the level of activity or output. This can be either a linear relationship or a step function. • Examples: Fuel cost for vehicles varies in a linear fashion relative to the number of miles driven. The number of instructors needed to teach a class can vary in a step function based on the number of students (e.g., 1 instructor for 25 students, 2 instructors for 26-50 students, etc). Fixed Cost • A cost that does not vary based on the level of activity or output. • Example: At an Army installation, the cost associated with the commander and his/her immediate staff is unlikely to vary as the installation population or other variables change. Note: Most costs are semi-variable Variable Semi-Variable Fixed Cost 44

45. Sunk Costs Costs that have already been incurred and cannot be changed no matter what action is taken in the future are called Sunk Costs Example: Paul is assembling his new home theatre system. He has spend 5 hours thus far and estimates he will complete the assembly in 2 more hours. Joan informs him he is doing it the hard way and describes a simpler approach which will take one hour to undo his work and re-assemble the system completely 45

46. Opportunity Costs • The size of a foregone opportunity of using a resource is the Opportunity Cost • Example • The opportunity cost of accepting a job is forgoing the opportunity to do something else with our time • If our best alternative to working is playing golf the opportunity cost of working is the forgone opportunity of playing golf 46

47. Marginal Costs • Marginal Costs are the costs to produce one more additional unit of output • Marginal costs are highest at very low output rates and at output rates near capacity • The slope of the ‘Total Cost Curve’ at any given level of production is the marginal cost for one more unit 47

48. B Lowest marginal costs Marginal Costs Total cost Cost C High marginal costs A High marginal costs Output 48

49. Average Costs Average Cost is calculated by dividing the total cost by the total units produced Average Cost is very high at low levels of output 49

50. Cost Behavior • Variable costs: changes in total in proportion to changes in the related level of activity or volume • Variable costs are constant on a per-unit basis • If a product takes 5 pounds of materials each, it stays the same per unit regardless of number of units produced • Fixed costs: remain unchanged in total regardless of changes in the related level of activity or volume • Fixed costs change inversely with the level of production • As more units are produced, the same fixed cost is spread over more units, reducing the cost per unit • Costs are fixed or variable only with respect to a specific activity or a given time period 50